ANALYSIS - Recession Slowing Water Investment To A Drip

Date:16-Apr-09Country: USAuthor: Nichola Groom

Water drips from a tap in London November 14, 2007.Photo: Toby Melville

LOS ANGELES - Water scarcity means big growth for companies that purify, transport and distribute the world's most essential resource, but a global recession that has halted new projects and put off price increases means water investors will have to wait for the boom years.

Water, cheap and indispensable, has long been prized as a stable investment in both good and bad times.

But as the population grows, urbanization tightens access to clean water and climate change promises more droughts, calls to upgrade the nation's crumbling infrastructure have mounted, and companies that make pipes, filters and other products that help manage water supplies have taken on a new shine as growth vehicles.

"There are tremendous needs in this country to replace aging infrastructure, especially water infrastructure, and now there is tremendous money able to be put toward those types of projects," BB&T Capital Markets analyst Kevin Maczka said, though he cautioned that investors should not expect a "windfall" for water stocks any time soon.

"Over a couple of years that will be a real investable theme," Maczka said.

CAN'T LIVE WITHOUT

Since water is so critical, demand does not trail off markedly during recessions, especially for utilities and suppliers of equipment needed for operations. Water stocks, therefore, have held up better in the current downturn than many others.

The water-focused exchange-traded fund, PowerShares Water Resources Portfolio, has dropped about 19 percent in the last six months, compared with a decline of 24 percent in the Standard & Poor's Industrials index.

"Water is one of, if not the absolute last thing you take away, so the income is quite stable," said Kimberly Tara, chief executive of Boston-based FourWinds Capital Management, which invests in water through its Aqua Resources Fund Ltd.

The recession, however, is taking a toll on growth as the credit crisis cuts off sources of funding, hitting companies expected to prosper most from an explosion in water demand.

"A lot of these companies were in expansion mode," Tara said. "So basically they are slowing their projects because they don't have access to capital."

With big projects few and far between, dour announcements from water companies have followed suit.

Late last month, Ameron International Corp said the market for water transmission pipelines in the water-stretched US West was well below historical levels. That came a month after Northwest Pipe Co said it would shut down a water pipe facility temporarily due to weak demand.

Meter and pump manufacturers whose customers include big water consumers such as the semiconductor, paper and petrochemical industries have also seen their sales hit, and one analyst said demand could stay weak for some time.

"It's going to be a while until these companies hit a positive inflection point in terms of their earnings -- at least probably a year," Boenning & Scattergood analyst Ryan Connors said.

One bright spot in the water industry is that operating budgets for municipal utilities, which make up 85 percent of the water utility market, have remained intact. That means water treatment companies such as Nalco Holding Co and filtration companies like Calgon Carbon Corp should have a steady stream of orders for chemicals and components needed to keep water clean and plants functioning.

"The water utility is probably faring a lot better than other aspects of the government," said Piper Jaffray analyst Mike Cox. "What is absent is that ability to issue municipal bonds to do large projects."

STIMULUS A DROP IN THE BUCKET

One potential source of funding is the $6 billion allocated to water projects in the US economic stimulus plan, though analysts said its ultimate impact on stocks could be small.

"The water industry runs at $250 billion to $300 billion a year, so it's just not enough to move the needle and offset some of the negative things taking place," Connors said.

An area of the water market that has moved forward despite the recession is desalination, a process long viewed as the Holy Grail in the quest to replace dwindling freshwater drinking supplies. Desalination plants are under way in the Middle East, Africa, Spain and China, helping Energy Recovery Inc, which makes devices that reduce energy consumption in the desalination process, log a 59 percent increase in fourth-quarter revenue.

Consolidated Water Co Ltd, which develops and operates desalination plants, also recorded higher sales in the fourth quarter -- a jump of 18 percent -- and said it does not need to raise capital for any of the projects it has under way.

Still, both stocks have been punished in the market downturn. Energy Recovery shares remain 20 percent below their July 2008 initial public offering price of $8.50. In that same period, Consolidated Water shares have dropped 35 percent.

About 20 desalination projects are in development in California, and analysts said that means the United States will one day be a big market for that technology.

But, for water investment to thrive in the United States as it has in countries like Australia and Israel, experts said scarcity will have to make life more difficult for American consumers and drive water prices up further.

Last year, global water tariffs rose 6.7 percent, but the United States lagged that at 5.8 percent. Nations such as Australia, Poland and Turkey, meanwhile, logged double-digit increases, according to industry research firm Global Water Intelligence.

Significant price increases are unlikely to be pushed through this year given the economic climate, Cox said, though he added that on average over the next five years, annual US water price rises should be higher than they were last year.

Higher prices, freer credit and droughts such as the current dry spell in California, now in its third year, will ultimately spur water companies to deliver the strong growth many investors have been banking on.

"There might be a delay ... but is this whole industry being put into question as to where it's going? No," said Philippe Rohner, manager of a $3 billion water fund for Geneva-based Pictet Asset Management. "It's not like we found out water cannot be used anymore."

(Additional reporting by Nick Zieminski in New York; Editing by Bernard Orr)